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Investment Overview for Norfolk Southern (NYSE:NSC)
WHAT HAS CHANGED
Two important factors have impacted the business prospects of railroad companies, such as Norfolk Southern, over the past few quarters -- weak fuel prices and declining coal shipments. Weak fuel prices and declining coal shipments have negatively impacted the company's operations.
- Weak fuel prices have negatively impacted operations
- Crude oil prices have weakened considerably over the course of the last twelve months, as a result of a global supply glut. This has negatively impacted the fuel surcharge revenues for Norfolk Southern, which are tied to either WTI crude oil prices or On-Highway diesel prices. However, low fuel prices have also helped reduce operating costs, which has partially offset the negative impact of weak fuel surcharge revenues, and declining coal shipments on the company's results. As a result, the company's operating ratio (operating costs as a % of operating revenues) worsened by only 340 basis points year-over-year in the 2015, despite a 10% reduction in revenues.
- Declining coal shipments
- A combination of an adverse regulatory environment and weak natural gas prices has undermined the demand for coal. As a part of the federal government's broader plans to reduce carbon dioxide emissions, it is targeting a 32% reduction in power plant carbon dioxide emissions from 2005 levels, by 2030. Since coal based thermal power plants have higher emissions intensity as compared to natural gas based thermal power plants, the prevailing regulatory environment favors natural gas, instead of coal, as the preferred fuel for electricity generation. In addition, weak natural gas prices have accelerated the shift towards natural gas as the preferred fuel for electricity generation. These developments have lowered the demand for coal, which has negatively impacted Norfolk Southern's coal shipments, which declined 15% in the first half of 2015.
Below are the key drivers of Norfolk Southern's value that present opportunities for upside or downside to the current Trefis price estimate:
- Norfolk Southern's EBITDA margin: We currently forecast Norfolk Southern's EBITDA margin to increase from 39.6% in 2015, to 43%, by the end of the Trefis forecast period, driven by the company's productivity improvement initiatives.
There could be an upside of roughly 5% to the Trefis price estimate if margin growth as a result of productivity improvement is above expectations and margins improve to 45% by the end of the Trefis forecast period as opposed to 43% in our base case forecast.
- U.S. Rail Carloads of Coal: We currently forecast U.S. Rail Carloads of Coal to decrease from 7.3 million in 2014 to 6 million by the end of the Trefis forecast period, as we expect a continuous decline in demand for thermal coal.
The decline in demand for thermal coal could be sharper than expected, particularly if gas prices remain subdued. If U.S. rail carloads of coal decline to 4 million tons by the end of our forecast period, as opposed to 6 million in the base case, it would imply a 5% downside to our price estimate.
For additional details, select a driver above or select a division from the interactive Trefis split for Norfolk Southern at the top of the page.
Norfolk Southern Corporation is one of the largest railroad companies in the Eastern United States, engaged primarily in the rail transportation of raw materials, intermediate products, and finished goods. Goods are primarily transported in the Southeast, East, and Midwest US, and via interchange services with rail carriers, to and from the rest of the United States. Norfolk Southern also transports overseas freight through several Atlantic and Gulf Coast ports.
Its principal subsidiary, Norfolk Southern Railway Company
is wholly owned. NSC also has a joint ownership, along with CSX, of the Consolidated Rail Corporation. Norfolk Southern's route map covers most of the eastern United States, east of the Mississippi River, the District of Columbia, and the Canadian provinces of Ontario and Quebec, covering nearly 22 states. Norfolk Southern's primary competitor is CSX Corporation which covers much of the same territory.
The company operates on 20,141 miles of track out of which 15,493 is owned outright and the remainder is pursuant to trackage rights or leases. Norfolk Southern offers the most extensive intermodal network in the eastern half of the United States.
Norfolk Southern’s business mix includes coal, intermodal, and general merchandise which is composed of six major commodity groupings: automotive; chemicals; metals and construction; agriculture; consumer products, and government; as well as paper, clay, and forest products. Although the company's primary role is transporting freight, its non-carrier subsidiaries engage principally in the acquisition, leasing, and management of coal, oil, gas, and minerals; the development of commercial real estate; telecommunications; and the leasing or sale of rail property and equipment.
Norfolk Southern's earnings depend upon the volume of freight contracts it sells, and the price of those contracts, while its expenses primarily consist of labor, fuel costs, utilities costs, and track maintenance. The largest of Norfolk Southern's customers include steamship lines, vehicle manufacturers, agricultural companies, utilities, intermodal companies, and chemical manufacturers.
We believe the Intermodal freight and Chemicals freight divisions are the most valuable divisions and account for more than 40% of Norfolk Souhern's total value. The key factors responsible for this are:
Tightening trucking capacity
Declining fleet sizes and inadequate availability of truck drivers have significantly tempered the freight transport capacity of the trucking industry. The Hours-of-Service safety regulation for commercial vehicle drivers has put pressure on trucking capacity by limiting the number of working hours for truck drivers. The tight trucking capacity will lead to high volumes of freight shifting to railroads. As the demand for railroads’ services increase, so will their pricing power. This provides an opportunity for Norfolk Southern to corner a larger share of U.S. intermodal shipments.
Growth in U.S. oil and gas output
Robust growth in U.S. oil and gas output has boosted the shipments of the Chemicals Freight division, which transports a range of petrochemicals and related products. Though Norfolk Southern has benefited from this growth through an increase in carloads for its Chemicals Freight segment, the shipments of crude oil and frac sand have declined with a fall in oil prices in 2015. Current shipment levels of Chemicals freight are enough to make this the company's second most valuable division, though the situation may change if the division's shipments fall sharply due to an extended downturn in oil prices.
Weak coal market
CSX's coal shipments declined 16% in 2015, as the demand for thermal coal fell sharply. A combination of an adverse regulatory environment and weak natural gas prices has undermined the demand for coal, with utilities shifting towards natural gas as their preferred fuel for electricity generation. Besides the decline in demand for thermal coal, the demand for metallurgical coal, which is used in steel production, has also weakened considerably. Oversupplied global markets, plummeting steel prices and a strong U.S. Dollar have weakened met coal shipments, most of which are meant for export markets.
Decline in fuel prices
The decline in fuel prices has been a double-edged sword for the railroad industry. On one hand, it has reduced the fuel surcharge that railroads add to their prices, thereby eating into their top line, while on the other, it has reduced fuel expenses, which has helped offset the impact of lower fuel surcharge revenues on profits. The decline in fuel surcharge revenues has resulted in a decline in average revenue per carload across shipments of various commodities despite core pricing gains in the case of certain commodity shipments.
How Does Trefis Modelling Work?
How do we get the historical numbers for this chart?
Trefis has a team of in-house Analysts who gather historical data from company filings and other verifiable sources. When historicals are available, we explain how we got them at the bottom of the Trefis analysis section below.
Who came up with the Trefis forecast for future years?
The Trefis team of in-house Analysts considers a variety of factors when projecting any forecast. The rationale for our projections is explained in the Trefis analysis section below.
How does my dragging the trendline on the chart impact the stock price?
- We use forecasts for business drivers to calculate forecasted Revenues and Profits for each division of the company.
- We then use forecasted Profits in a Discounted Cash Flow (DCF) model to obtain the Price Estimate for the company.
See more on: DCF Methodology
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